5 tax rules to consider when paying off student loans
Paying off your student loans can be a real pain. Whether you have a standard repayment plan or you've signed up for an income-based repayment program, it's best to get rid of your student debt to avoid facing some steep consequences. While you probably aren't thinking about taxes when you're making your monthly payments, there are certain tax rules that affect student loan borrowers. Check out five that can either help or hurt you during tax season.
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1. Student Loan Interest Is Tax Deductible
If paying off your student loans is at the bottom of your priority list, the opportunity to claim the student loan interest deduction might be enough to motivate you to begin making payments consistently. For tax year 2015, you can write off up to $2,500 of paid interest. The student loan interest deduction is an above-the-line tax break that you can claim on Form 1040 or Form 1040A regardless of whether you itemize your deductions or take the standard deduction.
2. Filing Status Determines Who Can Claim the Tax Break
The bad news is that not everyone is eligible for the student loan interest deduction. There are income limits and phaseouts that vary depending on your filing status. And while there are good reasons for spouses to file their taxes separately in certain cases, spouses are not entitled to a tax write-off for their paid student loan interest if they submit two different tax returns.
Married couples who file jointly can qualify for at least part of the deduction if their modified adjusted gross income (MAGI) falls below $160,000. Single filers or individuals who file as the head of their household or a qualifying widow(er) can't qualify if their MAGI is $80,000 or more.
Related Article: 3 Reasons Married Couples Should Consider Filing Taxes Separately
3. Your Filing Status Can Affect the Size of Your Debt Payments
Revised Pay As You Earn (REPAYE) is the newest income-based repayment plan available to folks with student loans. Anyone with a direct federal student loan can apply for the new payment program, which limits the monthly payment to 10% of a borrower's income. Neither your income level nor the year that you first took out the loan matters when determining your eligibility for the program.
While REPAYE will be beneficial to millions of people saddled with student debt, married couples could see their monthly payments rise substantially. The rules say that it doesn't matter whether couples file separately or jointly at tax time. Either way, the size of their monthly payments will depend on the incomes of both spouses put together.
In contrast, the other income-based repayment plans look at income separately for spouses who file separately. So if you qualify for the original PAYE payment plan, for example, you could possibly lower your monthly debt payments by filing separately from your spouse.
4. Forgiven Debt Can Count as Taxable Income
Being eligible for an income-based repayment plan like REPAYE can come in handy if you're struggling to keep up with your student loan bills. Plus, if you make your payments on time, your debt can be wiped away after a certain number of years. But forgiven debt is usually taxable.
That means that if the government forgives the $10,000 you still owe after 25 years, that money would be considered part of your income and you would have to pay taxes on it. There are some exceptions to that tax rule, however. For borrowers who participate in the Public Service Loan Forgiveness Program, the Teacher Loan Forgiveness Program or a similar program, their forgiven debt is not taxable. Filing for bankruptcy is another way to avoid having your canceled debt subject to taxation.
Related Article: 3 Reasons Banking on Student Loan Forgiveness Is a Bad Idea
5. Debt Relief Scholarships and Grants Can Be Taxable
In order for a scholarship or grant to be tax free, you must use it to pay for education-related expenses that you need while you're earning a degree. Certain programs and education-based nonprofits – such as Teach for America – offer awards that student loan borrowers can use to pay off some of their debt. Some of those awards and grants are taxable, as are debt relief scholarships for borrowers who are no longer in school.
The Bottom Line
Whether you plan to pay off your student debt in 10 years or 20 years under an income-based repayment plan, it's a good idea to keep in mind that your actions can affect your tax situation. Forgetting tax rules can cost you quite a bit when it's time to submit your tax return.
Related: 5 useful money tips
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